By Paul Atkinson
The observance of Independence Day comes around mid-year and thus serves as an appropriate time to look back and ahead at the US economy and equity market.
Interestingly, towards the end of the 18th century, the two major political parties at the time – the Federalists and Democratic- Republicans – held separate Independence Day celebrations in several large cities. Now, we simply celebrate with backyard barbeques, fireworks, and a bipartisan holiday which only became federally observed as recently as 1941.
The past few weeks in financial markets have seen some fireworks of their own, most notably the recent bond market selloff. The sudden decline that began second half May was attributable almost exclusively to anxiety over the possibility of higher interest rates – evidence of economic growth materialising – rather than any specific inflation threat. Looking ahead, we believe that the discussion will centre on the pace of the rise in interest rates and the scope for GDP to return to higher pre-financial crisis norms absent the zero interest rate policy. We continue to see several bright spots across the landscape. The US housing market, a major economic growth engine, remains healthy. Moreover, home affordability remains high despite an average increase of 80 basis points in 30-year mortgage rates following the bond market downturn in May and June. Additionally, several recent surveys have indicated that the US consumer, the dominant force in the economic hierarchy accounting for about 70% of GDP, remains confident post the improvement in personal balance sheets and signs of growth in real disposable incomes. Promisingly, this uptick in confidence has occurred despite relatively weak GDP and mixed but improving employment data. Importantly, inflation expectations remain well anchored.
Corporate performance remains healthy and is generating record levels of profitability for American companies. The more than doubling of the S&P 500 Index since the lows of March 2009 has a solid foundation. Relative to history, companies have strong balance sheets and are generating cash. Chief executives and boards are showing admirable capital discipline and are balancing investors’ desire to see excess capital returned to shareholders with the need to invest in growth projects. Despite recent increases, dividend payout ratios remain at historically low levels and will go higher. As both domestic and international uncertainty wanes, companies will begin to increase capital expenditures in select areas. CEO commentaries suggest that an increase in industrial and manufacturing related spend is in the early stages and that a long awaited increase in enterprise IT spend is closer to realisation. This is why many investors entertain thoughts of a great rotation into more economically sensitive companies.
As always, politics provides the antidote to too much optimism. In September, Congress will again need to raise the federal debt ceiling. Although this year’s budget deficit has materially narrowed in the last six months, the perennial problem of how best to slow the growth of total government debt remains as elusive as ever. Aside the rhetoric of hope from all sides, we are no closer to a longer-term solution. An unfortunate consequence of the improving economy is that politicians are losing their sense of urgency and desire to act. For this reason and despite many of the economic and corporate improvements witnessed since 2008, fundamental economic repair remains a work in progress.
Paul Atkinson is head of North American equities at Aberdeen Asset Management
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